Steve Keen on why Krugman needs a new school of thought

Professor Steve Keen on Krugman's brush-off of heterodox economics. 

In his latest blog, Paul Krugman slings off at non-mainstream economists -- and the students at Manchester University campaigning for change to the economics curriculum -- for wanting fundamental change in economics. The status quo is fine, he reckons: move along folks, nothing to see here. Says Krugman in his latest post, Frustrations of the Heterodox:

“Here’s the story they tell themselves: the failure of economists to predict the global economic crisis (and the poor policy response thereto), plus the surge in inequality, show the failure of conventional economic analysis. So it’s time to dethrone the whole thing -- basically, the whole edifice dating back to Samuelson’s 1948 textbook -- and give other schools of thought equal time.

“Unfortunately for the heterodox (and arguably for the world), this gets the story of what actually happened almost completely wrong.

“It is true that economists failed to predict the 2008 crisis (and so did almost everyone). But this wasn’t because economics lacked the tools to understand such things -- we’ve long had a pretty good understanding of the logic of banking crises. What happened instead was a failure of real-world observation -- failure to notice the rising importance of shadow banking.

“Economists looked at conventional banks, saw that they were protected by deposit insurance, and failed to realise that more than half the de facto banking system didn’t look like that anymore. This was a case of myopia -- but it wasn’t a deep conceptual failure. And as soon as people did recognize the importance of shadow banking, the whole thing instantly fell into place: we were looking at a classic financial crisis…

“Events have also reflected very badly on the style of economics that prizes 'microfoundations' based on ultra-rational behavior over evidence, and rules any kind of ad hockery out of bounds. But the heterodox want more than that; they want to interpret recent events as a refutation of the kind of economics Simon Wren-Lewis, or Janet Yellen, or Larry Summers (as economist, not public official), or yours truly does. And that interpretation just doesn’t work. By all means, advance heterodox ideas if you believe they’re right. But don’t claim vindication from events that didn’t actually follow the script you wish they did.”

Thus does Krugman trash what he accurately sees as “an upwelling of frustration on the part of heterodox economists” like Tom Palley, and students at the University of Manchester (A post-crash manifesto to rebuild economics) about the failure of economics to change after the financial crisis. No need for change, boys and girls: mainstream economics has everything under control. We missed the crisis just because we failed to observe the shenanigans in the shadow banking system. Once we realised our observational errors, we had all the necessary tools and knew what to do. (Oh, and what the rebels said would happen didn't anyway, so there!)

Read the rest here.